Asset to equity ratio
/What is the Asset to Equity Ratio?
The asset to equity ratio reveals the proportion of an entity’s assets that has been funded by shareholders . The inverse of this ratio shows the proportion of assets that has been funded with debt . For example, a company has $1,000,000 of assets and $100,000 of equity, which means that only 10% of the assets have been funded with equity, and a massive 90% has been funded with debt.
How to Calculate the Asset to Equity Ratio
To calculate the asset to equity ratio, divide total assets by total equity. A variation on the concept is to strip out all intangible assets, thereby focusing attention on the proportion of tangible assets being funded with equity. The formula is:
Total assets ÷ Total equity = Asset to equity ratio
Understanding the Asset to Equity Ratio
A low ratio indicates that a business has been financed in a conservative manner, with a large proportion of investor funding and a small amount of debt. A low ratio should be the goal when cash flows are highly variable, since it is quite difficult to pay off debt in this situation. A higher ratio is tolerable when a business has a long history of consistent cash flows, and those cash flows are expected to continue into the future.
A high asset to equity ratio can indicate that a business can no longer access additional debt financing, since lenders are unlikely to extend additional credit to an organization in this position. Also, if a business has a high ratio, it is more susceptible to pricing attacks by competitors, since it must maintain high prices in order to generate the cash flow to pay for its debt.